Adjust LTCG against the Basic Exemption Limit and Save Income Tax

Income Tax is one of the most complex subjects in India. Most of the taxpayers struggle on this front. Through the posts on this blog, i always share my learnings, means and ways to save Income Tax in a legitimate way. The objective is to decode and explain the complex income tax rules in a simplified manner. In this post, i will share how a taxpayer can adjust LTCG against the basic exemption limit. Thus tax savings for the taxpayer.

Some of the points shared in this post are already discussed in earlier posts. I hate being repetitive but some of the readers might not be able to comprehend. The reason being, previous posts were written in different context. Therefore, i have summarized some of the critical points relevant for this post. It will help to understand the subject fully in a single post.

What is LTCG or Long Term Capital Gain?

Typically, LTCG or Long Term Capital Gain is the gain due to the transfer of capital asset held by the taxpayer for more than 36 months. I discussed the topic of LTCG in my post, Capital Gain Tax – Long Term Capital Gain. The holding period for calculation of LTCG is 12 months for following capital assets

• Listed shares (In the case of unlisted shares, w.e.f. AY 2017-18, the holding period is 24 months instead of 36 months)
• Equity mutual funds
• Listed securities like debentures and Govt Securities
• Units of UTI
• Zero Coupon Bonds

The LTCG is NIL u/s 10(38) for listed shares and equity mutual funds i.e. if holding period is more than 12 months then there is NO Tax liability. This exemption is not available on preference shares. The definition of equity mutual funds is a mutual fund with 65% or more investments/investible funds out of total AUM, invested in equity shares of the domestic company.

From 1st April 2017 the exemption on LTCG (Nil Tax Liability) will be available even in cases where STT (Security Transaction Tax) is not paid provided

• The taxpayer has undertaken a transaction on a recognized stock exchange. The stock exchange can be located in any of the International Financial Service Centre.
• The amount paid or payable for such transactions is in Foreign Currency

In the case of all other asset classes, a taxpayer has to pay LTCG tax. The tax treatment of LTCG from the property is slightly different. You may check my post, Long Term Capital Gain from Property – 11 Least Known Facts. Though LTCG from the property can also be adjusted against basic exemption limit.

At the same time, it is also important to understand short term capital gain. You can also check my post on Short Term Capital Gain.

Basic Exemption Limit:

Basic Exemption Limit means the income level up to which a taxpayer is not required to pay any tax. We will discuss the case of Resident Indian and NRI’s separately. Reason being, the rules, and tax treatment is different for resident Indian and NRI.

(a) NRI or HUF: The basic exemption limit is Rs 2,50,000 irrespective of the age of the taxpayer.

(b) Resident Indian: The basic exemption limit is linked to the age of the taxpayer. The limit is as follows for FY 2016-17. The limit is not fixed and can be revised by the Ministry of Finance

• Age of 80 years or above: Rs 5,00,000
• Age of 60 years or above: Rs 3,00,000
• Age of below 60 years: Rs 2,50,000

Just to clarify that exemption is available on taxable income. For example, assuming my age is 40 years and my Gross Income is 3.5L. If i invested 1.5L u/s 80C then my taxable income is 2L. Therefore, my taxable income of 2L is less than the basic exemption limit of 2.5L. Hence, my tax liability will be NIL.

Adjust LTCG against the Basic Exemption Limit and Save Income Tax

One of the most common queries received by me during tax season is that a taxpayer has booked LTCG from the capital asset. The only catch is taxable income of a taxpayer is NIL or below basic exemption limit. The taxpayer is in a dilemma whether to pay tax on LTCG or not. In some cases, the taxpayer is NRI. The answer will depend on the residency status of the taxpayer. In other words, the tax treatment of LTCG in case taxable income is below basic exemption limit is different for NRI and Resident Indian.

(a) NRI or Non-Resident HUF: A Non-Resident Individual or Non-Resident HUF cannot adjust LTCG against the basic exemption limit. Therefore, in the case of NRI even if the taxable income is NIL and he has booked long term capital gain against the capital asset. NRI has to pay LTCG tax at the rate depending on the asset class.

(b) Resident Indian and Resident HUF: Needless to mention that Resident Indian and Resident HUF can adjust LTCG against the basic exemption limit.

In India, the general tendency is to evade tax and find out innovative ways to evade tax. Sometimes it is unknowingly but most of the times it is knowingly. It is important to understand rules and regulations to avoid notice from Income Tax Department. Recently, i received a query from Ms. Y. She works as an office assistant in Mumbai. Her taxable salary income is 1.75L and she booked long-term capital gain of Rs 67,000 through the sale of Gold Jewellery. The tax rate, in this case, is 20% with indexation.

She asked me whether she can adjust LTCG against the basic exemption limit of 2.5L. Therefore, if the reply is affirmative then her tax liability is NIL. In other words, Taxable Salary Income + LTCG = 2.42 i.e. below basic exemption limit of 2.5L.

Before answering her query, i casually asked her besides salary income whether she has “Income from other sources” predominantly dividend income, interest income from Fixed Deposits or Savings Account Interest (> Rs 10,000). She replied that her income from other sources is Rs 33,000.

Therefore, what she was planning to do was to first adjust the LTCG under basic exemption limit and then add income from other sources. By doing this she could have saved Income Tax. Her Taxable Salary Income + LTCG is 2.42L. Now add income from other sources i.e. Rs 33,000. Therefore, her total income is 2.42L + 0.33L = Rs 2.75L. She would have paid 10% tax on income above basic exemption limit i.e. Rs 25k. This is wrong way to calculate income tax.

The LTCG can be adjusted against basic exemption limit only after adjusting all other income. Therefore, in the case of Ms. Y, she should add income from other sources to taxable income i.e. 1.75L + 0.33L = 2.08L. Assuming she does not have any other source of income. Now she can adjust 42k LTCG out of 67k against basic exemption limit. Balance LTCG of 25k will be taxed at 20% (plus 3% cess). Therefore, her tax outflow will be higher compared to the original calculation.

LTCG cannot be adjusted against the deductions under Chapter VI-A

Last but not the least, any investment made u/s 80C or any other deduction under Chapter VI-A (various sections) cannot be adjusted against LTCG. For example, in one of the case, a resident Indian (age below 60 years) booked the LTCG of 6L. He does not have any other source of income. Basic exemption limit is 2.5L. Therefore, he should pay LTCG tax on 3.5L after adjusting basic exemption limit.

He invested 1.5L in PPF. He also paid for health insurance premium of Rs 20,000. He adjusted these investments of 1.7L (1.5L + 20k) against LTCG of 6L. Hence, according to him, LTCG tax is applicable only on 6L – 1.7L – 2.5L = 1.8L. It is wrong calculation and is not allowed. In his case, LTCG tax is applicable on 3.5L. He cannot claim any tax deduction against investments u/s 80C or 80D against LTCG.

For more tax savings tips, you can check my post, Income Tax – 51 Important Points.

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